Podcast: Play in new window
- Click Here To Buy Sir Paul Tucker’s Book: Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State
- Sir Paul Tucker on Paul Volcker & the importance of self-restraint
- In 2008 government relinquished massive power to the central bankers
- Gold standard replaced by central banks must come with mandates of limit
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Unelected Power: Caging & Limiting Central Banks
December 11, 2019
“Somehow today’s central bank leaders need to find a way of disabusing the public of that and weaning politicians off it, and weaning, most recent, global capital markets off the drip, drip, drip of support without cracking things in the process. That’s much easier for me to sit here saying to you than it would actually be to do. But that’s what I think they need to do. “
– Paul Tucker
Kevin: Our guest today wrote a very long but fascinating book on limiting the power of what seems to be unlimited power – Paul Tucker.
David: The title of the book is Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State. He comes at this with 30-plus years of experience as a central banker. We are very familiar with being on the Ph.D. standard, that is, we have central banks who are making decisions as it relates to monetary policy, and that Ph.D. standard replaced the old gold standard. It is now the who, instead of the what, which serves as the anchoring for our monetary system.
Kevin: Look at Paul Volcker, who just passed this week. He really was very independent of the political system. That could be argued. But in a way, we needed something like that. We had come off of the gold standard. And so if you’re going to anchor on anything other than gold, and you’re going to a central banking system, whether you agree with it or not, you had better have somebody that you know is independent and can be trusted, and has limited power.
David: Yes, a central banking system based on something other than a commodity. So here we are, a seminal moment in the history of finance, in the history of monetary policy, and we are not going back. But to understand the present and to anticipate the future, what are the guard rails that we would put on policy-making, and on the mandates and the achievements that central bankers are trying to effect.
Kevin: One of the things I liked about the book, Dave, was a humility. This is a man who has been in central banking now for over 30 years who is now saying, “Hey listen, you guys are expecting too much of us, and actually, you are giving us too much power.”
* * *
David: So, Paul, you are the author of Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State. You previously served as Deputy Governor of the Bank of England, and you are a past board member at the Bank of International Settlements. I could list your contributions at both the Bank of England and the Bank of International Settlements and it would probably take the remaining time today to do so. But suffice it to say, you know a few things about money and finance from a unique perspective.
Today you are Chair of the Systemic Risk Council. You also are the Research Fellow of the Mossavar-Rahmani Center for Business and Government at the Harvard Kennedy School. And in your free time also the Director of the Swiss Re, Senior Fellow at the Harvard Center for European Studies, President of the U.K.’s National Institute of Economic and Social Research, and I could go on and on and on. But it relates to financial stability, it relates to how we govern, it relates to what is involved in making decisions, both in terms of public policy and who does what.
And so, really, when you look at your book title, I think you have hit it straight on. The central bank component is one example of many of unelected power, and I’m looking forward to our conversation today.
Paul: Well, thank you very much for inviting me to be on with you, and I’m really looking forward to it, too.
David: This week, Paul Volcker died at the age of 92. He made a considerable contribution to the U.S. Federal Reserve as Chairman and continued to influence policy-making up to the present day with the Volcker rule and his contribution to Dodd-Frank. He took the helm at the Fed in 1979, and Paul, you happened to join the Bank of England in 1980, where you served until 2013, a long stretch, and you share more than a first name and a strong reputation. Your contribution to the design of policy regimes included many things, including setting up the Hong Kong Securities Regulatory Agency after the crash in 1987, so financial crisis and change in policy implementation, you have kind of seen and done a lot in your tenure.
Upon reading your book, Volcker wrote you a glowing review. He was a fan, shall we say. Let me give you my first impression and then let you respond. My first impression of your book is that there are many things that you care about at a more foundational level than, say, dynamics of [unclear] general equilibrium. There is philosophy, there is literature, there is political theory, and those things serve as a basis for your observations and prescriptions within the realm of central banking. And that is meaningful to me. Another impression is that while you are an advocate of central banking, and of central bank independence, you want to explore the limits of power and the sustainable roles to be played by an independent agency.
So my impression is that perhaps you have a concern, perhaps too much power, too many mandates, may raise, whether it is the ire of the delegating political class or the people in some sort of populist revolt, and might in fact end the whole endeavor. With that in mind, maybe you can bring me closer to what actually motivated your writing of this book.
Paul: Well, you have penetrated to the heart of the book, if I may say so. Let me just start by saying a few words about Paul Volcker. Even though he was 30 years older than me [unclear] almost exactly, he and I became friends. I first met him at the back of a room, probably, in the mid 1980s when he was chair of the Fed, but I got to know him much later. This is a truly gigantic public servant, but a wonderful man, too. He had no sense of rank or age or seniority. To know him and to work with him was a privilege. To have his support on various things was just a blessing. He is an enormous loss, not just to the United States, but to the world, frankly. The world is a slightly less safe place this morning for Paul’s passing.
I think he agreed with this point, by the way. He was anxious whether I was attacking central bank independence. I think I persuaded him that I wasn’t, but I thought that we had to be very careful about it because there has been a massive change in our societies over the last 80 years or so in the United States, maybe 40 years on this side of the Atlantic. I can best conjure this up by talking about the crisis of the Great Depression. If you think of whose face you most associate with bringing the United States and the world out of the Great Depression, and then reforming the system afterward, whether one likes the reforms or hates the reforms, which face? Everyone will answer President Franklin D. Roosevelt. If you ask in the United States which face or faces you associate with avoiding a repeat of the Great Depression, getting the United States through and out of the crisis in 2009-2010, Ben Bernanke, Hank Paulson, Tim Geithner. On the European side of the Atlantic, people would say, Mario Draghi, Jean-Claude Trichet. None of these people were elected. This is an absolutely massive change and somehow it captures the realities of where power lies in our societies. And I don’t think it is a good, for two quite different reasons. The first is, there are some things that politicians are really good at, and that unelected people aren’t. I’m lucky enough to have known quite a few really eloquent top central bankers and top regulators. None of them have that special magic that the best politicians do, of being able to explain things in words that resonate with regular people, whether they are listening over their breakfast, driving in to work, capturing it on TV in a bar or something.
If you think about the crisis in the fall and winter of 2008, spring of 2009, neither president, Bush II nor President Obama, fronted it in the way that Franklin Roosevelt did in the 1930s. So I think something is lost by that at the level of just delivering and persuading people, explaining to people why things were being done in their name, why their money was being spent to rescue Wall Street.
But I think there was also a deeper point, which is that we elect the people who govern us for a good reason. I think almost the central genius of representative democracy is that it separates how we feel about government of the day from how we feel about the system of government, and that is because if we get fed up with the current administration, the previous administration, what in Britain we would call the government of the day, we just vote them out and try another lot, try the other side.
Well, you couldn’t vote me out of the Bank of England. You couldn’t vote Paul Volcker out of the Federal Reserve. That’s a big deal, and we should be careful about unelected power of that kind. I don’t want to abolish it. There are some people that do. I don’t want to abolish it, but I think we have to be careful about it and we have to understand this isn’t just about doing a good job, being experts in a particular field, because in every field things eventually go wrong, and we need the people, the public, to feel, “Well, we don’t want to turn over the barricades, we’ll just try some different policies.”
David: When we think of the distribution of the balance of power within our system of government, we think of the three parts of government, the legislative, the judicial, the executive branches. We don’t always think of the powers that are wielded by nonelected agencies. As you pointed out, that power has increased through time, to people that sometimes are well known. I guess the popularity of some central bankers has grown through financial crisis, but many more technocrats that are really doing their jobs and are not known. These powers have become considerable. Is that a compromise to the balance of power between those three parts, or an extension of the balance in just a more practicable form?
Paul: I think in some ways it enriches the checks and balances in the system. It matters enormously, and this is true in the United States and in the U.K., slightly less true in the euro area. What Congress or Parliament bestows, Congress or Parliament can take away. That’s really important. These central banks or regulators aren’t standing equal with the three canonical branches which are in the U.S. Constitution and which are in British political tradition. These are delegated powers, however great those powers are now.
The second thing to say is, and I don’t think this is said enough, actually, is the special point about the monetary power. I would suggest that the last people that should hold the monetary power are the elected executive branch, because the monetary power is always latently an instrument of taxation. If while we’re sitting here talking to each other a long way apart the Federal Reserve increases the amount of money in circulation by 100 times, or 10 times, and promises to leave it there forever, then inflation will increase, and that will redistribute resources from creditors to debtors, and it will reduce the burden of the government debt, as well. That is a form of taxation.
Now, we all want taxation to be decided by the elected assembly, not by the president or the prime minister. So in some respects, I see central bank independence as [unclear] of that element of the separation of powers, the separation between the elected executive and the elected assembly. But the central bank then needs to be heavily constrained so that it doesn’t turn itself into the monarch.
The reason I think that kind of picture is worthwhile is that before central bank independence was re-established presidents and prime ministers did control the printing press. When in the 1970s the United States suffered unexpectedly high inflation, it was effectively being taxed by the president without Congress’s approval. And that is a big thing. I think if we’re careful, and it is vital to be careful, I think that central bank independence kind of enriches and reinforces the separation of powers which is something that lies right at the heart of our shared political values.
David: I’m very curious what you think should be delegated and when should we be cautious in doing so. I recall a conversation with Carmen Reinhart where she expressed to us that repression is a different model, or a different tool that central banks have had and use within their monetary policy framework and it also allows for moving resources around on the table. I think her precise words were “choosing winners and losers.”
I understand that is not a power you necessarily want in the elected executive, but when you hand that power to an unelected delegated power, A) how do you maintain your democratic values, and B) is that kind of power to choose winners and losers in the process of what is technically called financial repression, is that a power that a group like a central bank or banker – is it too much power?
Paul: Yes, it would be too much power if they’re making the choices. I think if the mandate is carefully drawn up, Congress or Parliament can delegate in a way where there are distributional effects, but they are baked in from the beginning. When I think you reach the point, an example Carmen gives where interest rates are held so low for so long that it is a form of redistributive policy, and she has talked about Japan in that context, I think it is incumbent upon the central bankers as citizens to go to the legislature and say, “Look, we’re at the edge of our mandate. We can do these things legally, but we’re now going to be doing things that will have the following side effects, or even what would be the main reason for doing them to get the economy out of the mess that it is in. We can do that within the law as the law is properly construed or by our experts who construe it, but actually we think there is a big political hurdle here and you as Congress or Parliament need to know and we need to know whether you bless this or not.”
And I think there is a slightly subtle point here in that I think it is vitally important to write these delegated mandates primary legislation that creates these agencies, Federal Reserve, incredibly carefully. You will never cater for everything. And then you need the members of the relevant committees in Congress and Parliament and the Fed leaders, the Bank of England leaders, the European Central Bank leaders, to be open about when they are in uncharted territory with likely effects that no one contemplated when the regime was set up, and you just need to go and be open with the politicians about that, and give them the choice to say, “You don’t have our support for that at all.”
I can imagine some of my former colleagues around the world, not just in the U.K. actually, saying “This is a betrayal of independence. You will be diluting our independence.” And my response to them would be, “Hold on, no, not at all.” It’s when you are the boundaries of anybody’s understanding of what powers you are being delegated, then it is the responsible thing to go back and check and do that openly. Democracy comes first.
David: That brings me to my next question because the power of central banks has changed through time, and I wonder if that is as a consequence of crisis dynamics or delegation from politicians who are either unable to unwilling to act. You mentioned earlier that both from Bush and Obama there was almost a sitting back and waiting for the central bank community to get active, whereas they did not step in as a Roosevelt would have. Or is this change in power which the central banks have just the natural evolution of the original mandates?
Paul: I think it is all of those things, actually, in ways that we could talk about for hours. Let me pick up, first of all, on the politicians’ incentive. There is no doubt, and this is well documented by political scientists in the U.S., that members of Congress and the president of the day have incentive to step back and let various agencies take blame. We might come to this later, but this is a world in which Congress gives up being an active legislator and hands it over to others. Too much of the debate in the States, and a bit in Europe, focuses on all the agencies doing too much, but actually, the root of this, in some respects, is Congress and Parliament doing too little, in a world where politicians are real individuals with a need, by their own light, to get re-elected next time around, and that is a kind of demanding process. Half of this process, they definitely have incentives to leave a vacuum, and further, when it comes to central banking, faced with some kind of macro-economic emergency, and with legal obligations, the central bank has almost no choice other than to do more. That’s the first thing I would say.
The second thing I would say is that there have been massive changes just since the Second World War. The demise of Bretton Woods in the early 1970s, which Paul Volcker was very much a part of, and which was the last gasp of the old gold standard, that was a seminal moment because it meant that the underlying anchor was no longer a commodity. It was going to have to be some other kind of policy constraint.
Behind that, I think, lies a fundamental thing which is that the gold standard thrived as an anchor for a value of money during the 19th century before there was full franchise democracy. Since full franchise democracy everywhere since the beginning of the 20th century I think it has been more or less impossible to operate a commodity standard because it tends to lead to greater volatility in jobs and economic activity. In other words, when the bad times come, they come more sharply under the gold standard, even if it works really well to hold the value of money constant.
And so, if that’s right, and there was no going back under a commodity standard when Bretton Woods unraveled in the 1970s and the search was on – who would be the anchor? And the central banks, initially individuals in a way, Paul Volcker, himself, was the anchor. Here was a man who would keep his promise to maintain the value of money in an American citizen’s pocket, and it wasn’t going to be eroded away as it had been in the 1970s. So that was a massive change.
And the other change I would mention, I guess we should come onto this at some point, is the role of central banks and banking in maintaining the stability of the banking sector. When I started in 1980, and the first time I met Paul Volcker in the mid 1980s, as I said I was standing at the back of the room, central bankers accepted responsibility for the stability of the banking system as a whole. That went completely out of fashion in the 1990s. Even though the Federal Reserve held onto its banking supervision powers, they were taken a lot less seriously in that period. And in the United Kingdom responsibility for banking was moved away from the Bank of England for the first time in 300 years.
That proved to be a disaster because when the system collapsed in 2008, [unclear] in the middle of 2007 onwards, but then it collapsed in 2008. The only people that could keep the system going as lenders of last resort were the central banks. And that means that today there is a realization that you can’t push central banks out of banking supervision, you can’t marginalize their role in that. But then it means that there are these incredibly powerful bodies operating monetary policy, operating a financial market, acting as lender of last resort, and yet also setting the terms of trade for the bank industry.
Actually, it was that combination of responsibilities, and one of the two main architects of a new system in the U.K. that gave the Bank of England even more power. This is a lot of power. Under what constraint could this possibly be okay? And that power was involved in putting such constraints in place in the U.K. I wanted to write a book about what was really on the back of my mind when we were doing that. But these powers have accumulated partly as a consequence of crises and partly because politicians are not reluctant to leave the field.
David: This is a vital conversation because in the post global financial crisis environment we do have actions taken, but not necessarily a broad-based discussion at a popular level. There are just expressions of discontent for one reason or the other. You could be on the left or the right and still have your reasons for discontent. For central banks, there is what we see as the primary role, setting monetary policy. For the Federal Reserve, there is the clearly stated double mandate of price stability and maximum employment. And there is even, if you look a little closer there is an implicit fiscal policy role played by the Fed, as well, if you are controlling inflation you have some role fiscally.
But it seems, too, that post crisis there are other roles being played. And this is to your point that we see – I don’t know if it is a mandate creep, but there are apparently some unofficial mandates, whether it is no longer price stability limited to the currency itself, but also markets, so they are playing a role in the equity markets, playing a role in the bond markets, as stabilizer. There is the macro-prudential manager role. There is the bank supervisory role. There is the regulator. Maybe you can speak to these expanded roles and at what point should we say, “That’s enough, thank you.”
Paul: And there are debates today, but less perhaps in the United States than in continental Europe and a bit in the United Kingdom, about what contribution can central banking make to climate change or can they make to inequality. So my way through this is to say that the role of the central bank core mission is to maintain the stability of the monetary system. And that has two parts. One is maintaining the value of money in terms of goods and services that we [unclear] by, low and stable inflation. And the other is maintaining the value of private sector money, the deposits that we all use, most of all we use as private sector money – maintaining the value of that in terms of central bank money, which means stability in the banking system. Those two things are why central banks exist, and you can remove one or the other, or both, in various ways.
You can have a commodity standard which, up to a point, gets away from discretionary monetary policy. You could ban commercial banking. But that is not what societies have chosen to do. Societies have chosen to have what is called fiat money and to allow commercial banking. And so that’s our monetary system, that is our payment system, and the point of central banks existing is to preserve the stability of that monetary system, and they need to be independent from day-to-day politics to do that because otherwise the politicians would come to the temptation of allowing credit booms of various kinds. And once you start from that, one needs to be really careful about grafting on lots of other objectives, as opposed to thinking that these are things that we do in order to achieve those two core objectives.
I would re-write some of the legislation if I had a hand, if I was able to do so. While I think that central bankers ought to live by those two, by that sense of that core mission and explain why they are so powerful and the limits to their power in terms of that core mission, they shouldn’t, and actually, realistically, cannot promise to revive dynamism in the economy, they can’t improve productivity growth. While certainly what they do has distributional effects, central banks don’t cure inequality. While some of what they do affects the allocation of credit in the economy, they can’t cure climate change. Those are all problems the higher levels of government, the parts of government that we elect.
David: So setting clear boundaries, being clear on the core mission.
Paul: Yes.
David: It is still a bit unclear to me how much power is necessary to do that, and the conclusion, you say, but the effect is to concentrate a lot of power in the hands of central bankers. It should be no more than is needed to preserve broad monetary system stability, as you said, but no more than – again, where are the limits there, because under certain circumstances we have seen the extraordinary, the surprising, even the experimental tools come out of the box, which frankly, in previous periods of monetary policy, I’m not even sure they were conceived of.
Paul: Let me give you an example of where I think central banks should not go. When they are acting as lender of last resort to a stricken system, they shouldn’t lend to banks or other firms that they know are so fundamentally broken that they can’t be repaired. The reason they shouldn’t lend in those circumstances is what they are making is a fiscal transfer because the short-term creditors get away whole, and the long-term creditors are left even worse off is the thing that is fundamentally [unclear].
Sorting out fundamental problems of solvency is fiscal, and must either therefore go through the bankruptcy process, although these days there are special resolution procedures for banks and dealers, or be rescued by the fiscal authority. I am not advocating that, I’m just saying that’s the right of the fiscal policy-maker and they can then face the public. The central banker shouldn’t do that. This comes back to the incentives of the politicians again. When the decisions are most awkward, it is tempting for people to use the Federal Reserve as the U.S. cavalry.
David: What you are also getting at is not specifically a fiscal or monetary policy decision but a philosophical point that is uncomfortable for many people, dealing with fear of the unknown. If you do allow a financial institution to fail and you are not allowing for that fiscal transfer to take place, you have to accept the fact that there is an unknown set of consequences. And of course, there are unknown sets of consequences to every decision we make, but this is one where fear seems to predominate in the decision-making process.
So just kind of gathering it all in, we’re seeing this in China right now where we are seeing the forced mergers. So far this year it is four or five key financial institutions, none of the big ones, but being not big in China means that you have a balance sheet of 100-300 billion dollars. That is still pretty small in China. But you just sweep it under the rug, make the fiscal transfer occur, and prevent the dominos from falling. That is really the fear, it seems. Don’t let the dominos fall. We are in an interconnected financial environment. You can’t let “contagion” be there.
So I would agree with you, Paul, that there has to be limits and you can’t bail everyone out. As lender of last resort, if it is not credit, going back to Bagehot’s favorite position on that that you lend on quality assets at a high rate of interest, and that is just not being done. It is garbage assets at no rates of interest at all. Are we talking about fear of the unknown? Is it fair to put it in those terms?
Paul: Yes, I think so. And maybe democracies are particularly prone to this because the politicians will face the consequences of meltdown. But the strange thing would be, and this has nothing to do with elected versus unelected power. You would think in those circumstances the people would have very strong incentives to prepare for the worst, and ensure that, in this case the banking system, is designed to make it more resilient, and because you can never do anything perfectly well and extraordinary things can happen, have a clear plan for what you would do when, in the face of failure, a deep problem, not a liquidity problem.
Now, I have to say that since the crisis, quite a leap forward has been taken on that front. I’m [unclear] an international committee that drew up some of the key plans that have been implemented in the United States, but this is about the resolution, as it is called, of distressed funds. That has been too much at the tacky fringes of public debate, whereas when it all goes wrong and bailouts occur, or don’t occur, it moves absolutely to the center of public consciousness. And I have been surprised that the Federal Reserve in your country and the Treasury and their opposite numbers in the U.K. and continental Europe haven’t wanted the reforms on that front to be much more clearly in the public eye. That is what I think they ought to do. I think it works in their interest, as well.
David: Well, we have migrated, right? We were on the gold standard, now we have the Ph.D. standard, and to some degree, whether it is the politicians delegating, or the public not paying attention and not getting interested, I think to some degree it is “leave it to the experts” and there is not a lot of public dialogue.
Paul: So there is a natural tendency, as we said, for politicians to step back, and there is a natural tendency, thank God, then for the public – you and I are both members of the public, I’m not in office anymore – to want to get on with our lives and doing things. But I think the group that leaves is these so-called experts, technocrats. Rather than getting on with their role behind closed doors, they need to help generate interest in what they are doing, and try to explain themselves, including when they testify to Congress and testify to Parliament. These are extraordinary occasions when you can get some media interest, and you can say things to Congress or to Parliament. “We can only do so much. You should be legislating on it, you should be thinking about legislating on that.” A bit more of that goes on in the U.K. than in the United States, for reasons that aren’t completely clear.
David: In the Greenspan era, we would describe his communication skills, as you would like to say, as quite good (laughs). I think that is where the general public began to lose interest because no one understood “Greenspeak.” It was so opaque, and he was the only person who really understood what he was saying, I’m quite certain.
Paul: Yes, and that was mistake, actually. That was a misjudgment that served the institution well in the short run, but didn’t serve the institution well in the long run, and didn’t serve the American people well. If you hold high office in a democracy and you wield power, and you have some kind of duty, you also have a slow motion self-interest in ensuring that interested members of the public – not everyone is going to be interested, some will prefer to watch a sports match, which is fine, or whatever.
But interested members of the public, if they want to tune in, you should make it as easy for them to do so as possible. You shouldn’t oversimplify, you shouldn’t dumb down in a way where the substance gets changed. When you’re challenged, to say, “Well, of course, it’s not really like that.” You need to find ways of communicating the truth as you see it about the technical stuff, but in ways that, as I said, an interested member of the public who doesn’t have an economics degree or anything like that can tune in to what you are doing and not doing, and feel they understand how they are being governed, because this is part of the governance of the country.
David: When we think of the power of an independent agency, there are, in many instances, agencies who are writing legally binding regulations. Not just thinking of the central bank, but many other agencies. Is that any different than our legislators’ codification of law, and if not, then why not call those regulations, and why not call those independent agencies law-makers?
Paul: Well, I think you’re right, basically. I think that regulation and rules is a kind of euphemism, and these are legally binding norms that can be enforced with the coercive power of the state, rather grandly and abstractly. But it’s not straightforward law-making either. It’s not the same as making laws in Congress or in the in the Westminster Parliament or the Bundestag in Germany, because these regulations are passed by these agencies only exercising powers that have been delegated to them by Congress, by Parliament.
So then the issue is, is that delegation well thought through? Is it properly constrained? In the United States, there is, as I see it, a problem – there is certainly a widespread practice which I think is problematic – of Congress delegating to agencies in very vague terms, which sometimes amount to, in this particular field, whatever it is, go forth and do good. I feel that can be okay if, say, the delegation is time-limited, or if the agency has to go back to Congress each year to get funded, or if the president has the legal right to intervene and set policy, or if not the president, the secretary and cabinet-level secretary. But I don’t think such vague mandates are okay if the agency is insulated from day-to-day policy.
I would say, by the way, that the debate about this kind of thing in the United States, I think, is not very good because mostly people involved in the debate, namely legal scholars, fail to distinguish between agencies that are completely independent, agencies that are independent from the president, but have to get their money each year from Congress, which is quite a lever, and agencies which are under the day-to-day control of the core executive branch. And you need, I would say, that a healthy constitutional democracy needs different principles of delegation for those three types of agency. And my book is 99% about principles for the most independent agencies, of which there are relatively few in the United States, by the way, of which the Fed is the most important. There are many more of these very independent agencies in Europe.
David: You spend a lot of time talking about design precepts for trustee-like independent agencies. Over and over again, there is language of boundaries, and properly constrained, and accountability. So when we think of the guardians and the classic question of who guards the guardians, how would you suggest, as you create a trustee agent, a trustee-like independent agency, how do you suggest oversight and accountability for the administrative state? Is that even possible when you have mandates, like you said, go forth and do good?
Paul: I don’t think it’s possible if you have to go forth and do good. I don’t think that an agency that has a mandate as vague and broad as that should be insulated from day-to-day politics. I think if you insulate something from day-to-day politics you need to give it a clear mandate and constrain it in various other ways. And then imagine we’ve done that. Then there is the key occasion of hearings in front of the Senate and to some extent, in front of the House, as well. And then scrutiny, by the media and by the public, of the people sitting on the Senate committees and people sitting on the House committees.
There is a problem in the United States also and in continental Europe, of committees in the House just being too big to be effective. The Senate committees are a much more sensible size, but the members of the committees don’t necessarily stay for the whole of the hearing. They concentrate on their own question, and often the questioning, even of an independency agency like the Fed, ends up being a kind of proxy for party politics. That is something which the public and the media ought to be [unclear]. That’s a problem, not with the agency, it’s a problem with the people’s representatives, and the incentives they have.
So it is quite difficult to make all of this work, I think, unless those occasions are meaningful. When I left the Bank of England, they put on an occasion to mark my retirement and lots of people, I guess, important people from the U.K. and London were there and I made a speech and the last thing I said was, “What an extraordinary thing it was to have been delegated this power by the UK Parliament because to be able to testify and explain in public to Parliament how I was using my bit of the powers that they had delegated to the Bank of England.
And I’m not claiming special virtue here, but unless you think about that testimony as an extraordinary, extraordinary occasion, where you can explain to the peoples’ representatives how you have used your powers, powers you have been given on the peoples’ behalf, and you have to be able to try to do that in language that the public can tune into. I sometimes watch U.S. hearings and the questions are too long, and they are about the questioner, they’re not about helping the public understand how power is being used or not used. Not always, but sometimes.
David: So the environment here in the U.S., at least politically speaking, is highly contentious at present, and you have what appears to be an unsettling as you go around the world, various expressions of discontent, whether it is the Five-Star Movement, or Syriza, or what was the National Front, now National Rally, in France. What concerns are there today among central bankers with a general rise in populism on a global basis? If we look back on the history of central banking, at least for the U.S., this was a part of the demise of our first two attempts at central banking, populist rhetoric, and the accusations that there was only a benefit flowing to a select few, and some mandates were allowed to expire. Is there any concern amongst central bankers with this general rise in populism?
Paul: Yes, I think so, absolutely. It is worth saying something, by the way, about President Andrew Jackson’s vetoing of the renewal of the charter for, I think, the second bank of the United States in, I think, 1832. I have read the [unclear], it is technically called, and I have read the thing that he wrote when he was vetoing his veto statement. As I read it, the reasons that come across is, this bank is privately owned, some of the owners are foreign, non-American. It has tax exemptions, it’s got monopoly rights. And in a sense, I’m sympathetic to the lot of that, actually, and a lot of people which hold, say, libertarian views, will hold up Andrew Jackson’s veto as relevant to today’s central bank, but I just don’t think that is right. There may be other objections to today’s central bank, but I don’t think Andrew Jackson’s veto provides the model for principle objection to today’s central bank.
More generally, should our central banks be concerned about populism? Yes, I think for all sorts of reasons. One is that people, the public, expect too much of them. I have said already, but it is worth coming back to this, central banks can preserve the stability of the monetary system, but they can’t make the economy more dynamic, or productivity growth, which matters hugely. That has been weak, and weaker than usual in the United States. It has been very weak in Europe. Central bankers can’t cure that.
And to the extent that they become perceived, or have become perceived, to be the only game in time, the populist moment could become exacerbated when people naturally feel let down. “Well, these people were meant to be running the economy and it hasn’t improved, for me, Joe public, Josephine public, the central bankers need to get out.” Well, we’re not running the economy. We’re not running the country, and we’re certainly not running the economy. We’re preserving stability, we are trying to preserve stability of the monetary system, so that a market economy can function. But that requires all sorts of other things that have nothing to do with central banking.
What am I trying to say? There is a hazard [unclear] to be at the center or so much that there are always inevitably now unrealistic expectations of what they can do, what they can deliver.
David: I’m curious, when you say preserving stability, does that preclude business cycle volatility?
Paul: Well, I think some of that is inevitable. It depends where the volatility comes from. If the volatility comes from a spontaneous drop in spending for some reason, what economists would call demand shock, and stabilizing the economy and stopping inflation going down amount to one and the same thing. It’s harder when, say, while we’re sitting here with oil prices, I don’t know, quadruple or go up ten times and OPEC does something or other, then you have inflation temporarily rises and the economy becomes weak. What you have to do is allow some of the short run price pressure to run through the economy, but not let it affect people’s expectation of what inflation will be in two, three, four, or five years’ time, not with its permanent inflation rate shock. And if you keep people’s expectations of low inflation anchored then you can provide some support for the economy that reduces an unnecessary loss of jobs. And if you can do that, I think you should, but only as long as you can keep the medium-term anchor in place.
We talked about Paul Volcker earlier and the Fed has a duel mandate. Paul never used to talk about the duel mandate very much, if at all, and later he would explain why he didn’t, which is that, actually, given how people think the economy works, a duel mandate doesn’t really add very much in that what I have just described is what central banks and the Federal Reserve do, what the Bank of England would do, what the European Central Bank would do. The Bank of England and the European Central Bank do not have a duel mandate.
David: So this issue of anchoring expectations – I don’t know if you are familiar with Richard Bookstaber, who wrote a book called The End of Theory. He also wrote a book earlier, maybe 15 years ago, called A Demon of Our Own Design. He was head of risk management at Solomon Brothers. And then most recently, before he wrote The End of Theory, participated in consulting with the creation of Dodd-Frank. There are some interesting ideas that tie to this idea of anchoring expectations where it is more and more about managing perception and almost managing the public mind, where no longer are we tinkering with monetary tools, as much as we are public perceptions, and on the basis of getting in front of public perceptions and influencing public decisions, then all of a sudden you don’t have to play as much with actual monetary or fiscal tools.
Paul: It can be right. I think at some point – Ben Bernanke made a similar point. I can’t remember whether this was when he was in office or shortly afterward, but he said something like, monetary policy worked 95% – and he may have said more than that – per expectation, through people believing that we are going to do what we say we are going to do. I think that’s a bit overdone in that the rest of it is what economists call hydraulic effect, that if I raise interest rates there will be less money in your pocket to go shopping or make investments, and so on. But without that kind of mechanical hydraulic effect, the expectations channels, the persuasive channels, don’t get going. You believe my promise that I can do something to keep stable prices only because I have an instrument that has some mechanical hydraulic effect.
I remember having a debate in London about this some years ago, and they said “No, no, it’s all expectations.” I said, “Okay, the governor goes out onto the steps of the Bank of England, stark naked, and declares, ‘I will sort out the economy.’” I said, “Do you think that’s going to work?” And they said, “Sort out the crisis.” I said, “Do you think that’s going to work?” And they said, “No, it’s not going to work.” I said, “It’s not going to work because actually he hasn’t said how he is going to do it.” They will believe his promise only when he says, “Actually, I haven’t got a magic wand that is unbelievable, I’ve actually got some real powers that I can use that gain traction in the economy.”
Now, if that’s the case, and you have got tools that work, then what you are saying, and what Ben Bernanke was saying about the expectation effect, is very powerful, because it means you need to do a lot less than otherwise. If you believe I’ve got a tool that really will work mechanically, it turns out that I need to use that tool much less energetically than otherwise. I don’t need to generate a recession in order to bring inflation down. But people – members of the public and members of the [unclear] of financial markets – are rightly cynical about empty promises.
Going back again to Paul Volcker, he made a promise to bring down inflation. But no one believed him initially, and they pushed him straight up to 20% and there was an enormous recession. And only gradually did they come to believe him. Actually, I was slightly critical of Alan Greenspan earlier. One of Alan Greenspan’s singular achievements is that once Paul retired in his late 80s, if his successor hadn’t stuck at it, then people would have said, “Oh, that was just Paul Volcker, it’s not something we can trust from the Federal Reserve.” It was Greenspan that, in a sense, made the Volcker promise true.
And then people would say, “Oh yeah, we trust them to keep inflation low and stable.” And then you don’t need to engineer recession as much as had been the case. No one trusted the Federal Reserve after Miller and Arthurs Burns had been at the helm for 15 years. “We’ll keep inflation low, we’ll get inflation down.” These were empty words. So when people were negotiating their wage bargains each year, or when people running businesses were setting prices for the coming quarter or the coming year, they didn’t act on a belief that the Federal Reserve would bring inflation down. They acted on the belief that inflation would remain incredibly high.
David: So if you think of the financial market participants, we actually have multiple audiences. We have the general public who are out there earning and spending, in most cases, spend virtually everything that they do earn, the vast majority. But then there is the financial market participants, who, if there is credibility with the Fed, and you know that, as you say, behind the words there is a mechanical hydraulic effect, and yes, there is the power to deliver, they end up gaming the system.
Think of where we are today. By setting the cost of capital at record lows, you have the leveraged speculative community responding in a way that is very bold and although the central bank is doing a good job anchoring expectations, setting expectations, doesn’t that inherently, because of what it triggers in the leveraged speculative community, contribute to financial market destabilization, as greater bets are layered on?
Paul: Yes, I think there is a lot to be said about this, but I think the main thing is, yes. And so, could something be done about it? And I think the answer to that is yes, as well. But in circumstances where the full burden of supporting economic recovery has fallen to monetary policy so interest rates have been incredible low and quantitative easing the Fed’s balance sheet has been very big. I think what the central banks, again on both sides of the Atlantic – this isn’t a problem unique to the United States, could and should have done is, and I hope this isn’t too technical for your listeners – is they should have raised the minimum excess collateral requirement in derivative markets and certain other capital markets so that people had to put up more collateral and be less levered in these wholesale markets.
And they have the powers to do that. The Fed has had some powers in that area since 1930. And they have always been very reluctant to use them. But as far as I know, they have never asked for the powers to be taken away. One of the things I should say to the staff of the Bank of England is, you will rise through this place, if you discover that the Bank of England has powers that you are never going to use, ask Parliament to take those powers away. If you have powers you have a duty to consider whether or not you should deploy them for the purpose you were given them.
And I think, again, on both sides of the Atlantic, and in Japan, actually, I think the authorities could have done more, given no fiscal contribution, given no public infrastructure projects to speak of, if all the burden is going to be on monetary policy then that was going to risk creating froth in the financial market, and they then should have thought about, “How can we have our cake and eat it? How can we stimulate the economy but dampen the froth in financial markets. We talked a lot about independence and this is the way I framed it in the beginning of our conversation – independence from day-to-day politics.
But for these agencies in particular, the central banks, you also need to be independent from Wall Street. You need to be independent from the City of London. But there is no point in giving these agencies, these central banks, so much power, however well-constrained, if they feel they need to be popular with financial markets. There are all sorts of things that follow from that, by the way. Something I say in the book is that I think for the people who are the chairs and vice-chairs, the deputy governors of the central bank, I think it should be their last job. I think there should be no question of them being in the market for some other prize after that period of service.
You know, there are lessons to be learned from the military here as well. I think after the Second World War, perhaps during it, I think it was General Bradley, held the view that top generals shouldn’t vote in elections even though they are legally entitled to do so. I kind of felt that a bit about being a senior central banker. You need to be just a trustee of the powers you have been given and not trying to curry favor with anybody, including Wall Street, including the City of London.
David: It’s a big temptation. We’ve talked about mandates and them being crafted, specifically. We’ve talked about an expansion of power in certain circumstances. You’ve just addressed a very critical point which I think is a very magnanimous view. I don’t know how often it happens that in the aftermath of crisis, as there has been a ratcheting higher of power within both elected and unelected spheres, that people ratchet back the other direction. So government has grown. The roles that various agencies play have grown. Is there a point at which you end up with fiscal concerns because just the burden of the sheer size and scale of government is now just not really sustainable?
And yet we have gotten here through, whether it is the crisis of 1907, or here in the United States, and in Britain, the pound sterling devaluation 1929 to 1931, global financial crisis at that point. There are these series of events where, whether it is the New Deal or Dodd-Frank in a more modern context, there is an expanded role, but we never roll any of that back. I wonder, at some point, can we afford all of that and more?
Paul: It’s a great point. There is a senior professor at Yale called Roberta Romano who some years ago published papers advocating that powers of various regulatory agencies should have sunset clauses. There is this problem, go and fix the problem, after five years or ten years or whatever it is, Congress should review whether these powers are still needed. And there hasn’t been that because the shadow of the expiry would set in about two to three years before the expiry date would reach, which would politicize an agency that wanted to keep its powers because it enjoyed having them, and all that kind of stuff, which is not good. But we have to find a cure for this.
I believe in both government failure and market failure, but government needs to focus on the big things, like avoiding financial crisis is a really big thing, and is worth doing, because it completely up-ends social and political structures as we have seen across the Western world. You should be clear about what limited set of powers you need to do that. In the central banking field, central banks should be keen to get their balance sheets back down to some sort of normal size just as soon as they can.
Their problem, by the way, and again I hope this isn’t too technical for the listeners, is that in one sense the economy has recovered from the crisis, but the new pattern, the new underlying rate of growth, [unclear] productivity growth, is much lower than it was before the crisis. And what matters is whether that is temporary or whether it is going to persist for years and years. And if it is going to persist for years and years it is a massive problem.
And there are learned debates about whether or not this actually had started before the crisis and the credit boom and the housing boom was in fact just disguising the underlying malaise, or whether this malaise has set in after the crisis. But it is a big deal, and it is not something that central banks can cure. And I think central banks should be very open about that with Congress, with Parliament.
David: I wonder, if they cannot cure it, is a part of the issue that they might be enabling it? When I think of productivity growth on a smaller scale, at a micro level, with a corporation, you could look at a balance sheet and say a company that has too much going toward interest payments is going to have less that they can put toward research and development, toward developing future growth and productivity, again, at a micro level. At a national scale, perhaps the same thing can be said. I think of Ken Rogoff’s recent article in Project Syndicate where he says, “Government debt is not a free lunch.”
But arguably, hasn’t monetary policy, setting rates at zero or negative levels, created the incentives for massive corporate and governmental borrowing as if it were a free lunch? So now we have these scaled-up balance sheets disproportionately tilted toward liabilities, and really, the only thing that is keeping that sane is sitting on interest rates, arbitrarily keeping them low.
Paul: I think these are valid concerns, but I think it depends somewhat on how the borrowed money is used. Is the borrowed money used for things that improve the efficiency of the economy, improve research and development, and all the extraordinary things about the United States over the last 50, 60, 70 years, really since the Second World War, is that the research and development that lives in a space between the military and business industry has been remarkable and the whole world has benefitted from that. The reason I mention that is it is neither private nor public. It’s both. But it is certainly dependent at times on government initiative and even on government borrowing, or at least, government taxation.
And so, how one uses the money matters just enormously, and in a sense, part of what has gone wrong, I think, over the last 10-15, years including the [unclear] crisis is, with those making points in slightly different ways where our mindset of leaving it to the Federal Reserve, leaving it to the Bank of England, or the European Central Bank, and they will sort all of this out, is way off. Dynamism comes from within the market economy under the terms of trade set by government, which includes things like effective bankruptcy regimes, and all sorts of other things.
And anti-trust policy. I’m not an expert in anti-trust policy, but it seems to me that the debate about whether anti-trust policy should or shouldn’t be toughened is a really important debate, not just about power in the private part of the economy, but about the efficiency of the economy. It is important for people to get to the bottom of that issue in a scientific, careful way. Anti-trust policy matters probably more to the vibrancy of the economy than anything a central bank does.
David: So the dynamism comes from within the market economy. You have had several years to be away from the Bank of International Settlements and the Bank of England. How differently do you process, say, the daily news, various announcements and statistics that are put out there, as a citizen versus what could have been categorized as, and you have mentioned in your book, as an over-mighty citizen? Not that you were (laughs), but to use your phrase, you are no longer an over-mighty citizen. What does the view look like now as just a citizen?
Paul: It’s nice not having to be on top of all of the data nearly all the time. That’s a joy. But I think the extent to which – let me pick the United States and Germany as an example. Both need some infrastructure expenditure. It is quite remarkable that this doesn’t happen. It doesn’t have to be debt-funded, it could be tax-funded, but it didn’t happen at the core moment. I know the East Coast better than I know the West Coast. I’ve traveled across nearly all of America, but I know the East Coast better. I wouldn’t want to prioritize the East Coast, it is just what I have seen.
Some of the infrastructure there is way below international standards. And actually, improving it would improve the dynamism in that part of the economy. That is replicated across the United States. That is an opportunity. The late Marty Feldstein, Harvard professor, who passed away this year and who was Chair of the Council of Economic Advisors under a Republican administration, I think under President Reagan’s administration, maybe Bush I. He believed in infrastructure expenditure, but not debt-financed. This doesn’t have to be “let’s incur more debt.” But there is a need. There are some projects which government either needs to incentivize or just make happen, to make the economy more productive.
There are loads of other things that the government sector couldn’t possibly do, but instead need to ensure that the forces of competition deliver. And those are things that have nothing to do with the Federal Reserve or the European Central Bank or the Bank of England. And I go through them because I am dismayed as a citizen by how reliant people think the economy is on my old world, and somehow today’s central bank leaders need to find a way of disabusing the public of that and weaning politicians off it, and weaning Wall Street and global capital markets off the drip, drip, drip of support without cracking things in the process. That’s much easier for me to sit here saying to you than it would actually be to do. But that’s what I think they need to do.
David: For some time I have been concerned that we see the version of capitalism that is at play here in the U.S., and largely in Europe, and our system of representative democracy under threat due to a reaction, maybe not a clear understanding of what the issues are in play. So when I opened your book, there was kind of a resonance with, “Yes, there are some really key discussion points and issues that need to be tackled, policy related, that relate to not only central banks, but the way a government is operating and delegating power. And if it is not handled well, the street level reaction, as you mention, sort of hopping over the barricades in the early part of our conversation, that kind of thing could occur.
People have wondered how Trump was elected, where that came from, why the polls were so off. And as we talked about, again, Syriza, National Rally, the Five-Star Movement, there is a sense at which the system is no longer acceptable, and it is no longer good for us, whoever us is. But in a democracy there is the potential for radical volatility at the ballot box, and how safe, or how guarded, how protected is the system from that kind of reaction? I guess I’m going back to the 1780s and 1790s in France. Do you get to the point where the populist says, “This isn’t working for us. Your version of capitalism is killing us.”
Paul: We haven’t mentioned this word yet, but in a sense, what my whole book is about – legitimacy. I think the legitimacy of the system of government is all, and there is a thing in lots of political philosophers and theorists where they are talking about justice is more important. And I think that has been a mistake, and actually I think it is a mistake that has had real costs in the real world, in that it is having a legitimate system of government that allows us to have debates, really practical debates, not just talking for the sake of it, about what justice means and how to go about delivering whatever conception of justice we have, and by the ballot box. And so the legitimacy of our institutions matters a lot. When I first started writing the book a number of distinguished economists said to me, “Paul, what matters is results.” And my response was, the results sometimes are going to be bad you know, and therefore what matters is that when the results are bad the people who are being served don’t equate bad results – a financial crisis is a terrible result – that doesn’t alienate them from the system of government itself.
Now, just leaving that hanging for a second, the second thing I would say is that the ballot box, I think, is a wonderful thing. It is an enormous privilege to exercise our right to vote, if I could put it like that, but it is also a safety valve. And so, whatever one thinks of different political parties, as long as they are not abusing really basic human rights, this is how people register their discontent with the course of policy and demand change of various kinds.
Bringing this back to capitalism and the market economy, I’m in my early 50s. I think one of the striking things, looking back, about what people refer to as the Reagan/Thatcher revolution that, actually, in some senses began under Carter and Callahan after the mess of the 1970s, is that a lot of people, free market economists, believed there really would be a trickle-down effect to regular people, not just people in the top 1% or 10%, or 30%. And that hasn’t happened nearly as well as people thought it would. And in those circumstances, why on earth politicians didn’t think about, “How are we going to ensure that all communities benefit from the prosperity in the economy?” I think that people are rightly angry about that.
I think that people in America, I’m sure, should be incredibly angry about the opiate crisis. These are not my fields, but where they are related to what we are talking about is that if people feel let down, and then they think, “My God, we’re being governed by people that we didn’t even elect.” And the same goes for the judges, by the way. They have a higher place in the Constitution, not the right of Congress or in my country, Parliament, to affect their role, but the judges, too, need to be careful not to put themselves in charge.
David: I appreciated from the outset, even the introduction, laying out, I thought, a very fair description of the issues in play, not partaking in a particular partisan political view, but laying out not only the background, political theory, the philosophical issues, the assumptions that various schools of thought are based on. Really, what you have done in your book Unelected Power is lay out the scope of the conversation and help guide toward some practical applications of how to have healthy delegated power which is within a clear mandate which understands boundaries. There is a lot of practical experience speaking through, as well as rigorous theoretical work. Thank you for saving us from the DSGE. That is probably (laughs) less relevant for the man-on-the-street, more relevant for just the Ph.D. macro-economist, but it is a really ambitious project, and I think you have done a really good job of it.
Paul: Thank you very much. It has been a real treat for me to have this opportunity to talk to you today, and I hope that your listeners enjoy our conversation. If I may say so, I have enjoyed it enormously.
David: I hope our next conversation is downtown London, a glass of wine or a pint at your favorite pub downtown. Thank you so much.
Paul: Thank you.
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Kevin: One of my favorite quotes in the book, Dave, was on page 559. That is a ways into the book. But there is a humility there. He says, “At times, central bankers have been presented seemingly to enjoy their unparalleled status, power and prestige, but in fact, as they well know, they, like the rest of us, have a more tenuous grasp on what is going on in the economy than anyone ever expected.” Does that remind you of what William White told us, as well?
David: Absolutely, that there is a bit of art in this “science” of monetary policy-making. And it also made me think of Isaiah Berlin. As we talked to Paul today I imagined a similar conversation with Isaiah Berlin because at the transition of economics where you went from ideas being the underpinning for understanding an economic system and its functioning, to equations, giving you sort of a presumption of how much you know and how much you can control. Berlin dialed back from wanting to teach economics, and wanted to dial up again this notion that ideas matter.
So the fact that Paul has taken on this project and wanted the dialogue on these issues to be far more expansive, again, looking at political theory, looking at philosophy, looking at literature, looking at the impact and role of culture and sociology, there is a different way of approaching central banking in this book Unelected Power, and I think it is a very important contribution in the same vein of an Isaiah Berlin.
Kevin: Dave, honestly, I still would prefer gold as an anchor. I’m going to be honest with you. But if we’re going to have another type of anchor, I want it to be a thinking person, somebody like what you are talking about, versus an algorithm. I don’t want to give over our anchor to big data.
David: There is an echo here in terms of the conversation that we had with Giulio Gallarotti many years ago where we talked about the budget being politicized and the reality of not being able to go back to the gold standard because we are now in a full franchised democracy.
So that reality, that political reality, the change in time, of how we operate, and who we are as a people, dictating what works and what doesn’t, now not being on a gold standard, it is best that we understand the guiderails and the limitations, that old classic phrase, “Who guards the guardians?”
